World View & Market Commentary. Forest first; Trees second. Focused on Real & Knowable facts that filter through the "experts" fluff and media hyperbole. Where we've been, what the future may hold and developing a better way forward.

Saturday, April 11, 2009

Pilot Induced Oscillations (PIO) are induced when control inputs are out of phase with the cycle. The pilot, seeing the airplane yaw and roll to the right applies left aileron to correct, not realizing that the airplane would have corrected on its own had he not made any input at all! Yes, the plane may continue to sway to and fro, but when the pilot introduces his inputs, the sway, the yaw and roll GROW LARGER. This can and has become so extreme that the aircraft breaks up in flight!

PIO can also occur along the pitch axis:

Knowing that cycles occur in flight, pilots are trained in PIO and modern airplanes have computers (yaw dampers) that make small and timely control inputs to prevent them from occurring in the first place. That’s why you almost never spill your coffee while flying on a modern airliner.

Our economy goes through several cycles of varying degree all the time. A properly designed economy would have natural forces that damper the oscillations to keep them from growing too large. Incorrectly applied inputs force the cycles to become much larger than they naturally would. Greenspan lowering rates to zero? Bailing out bad banks? STIMULUS? Governments think they are the pilots of the economy, but they merely introduce inputs, mostly the improper kind.

Witness the lost decade in Japan (now approaching two decades). Propping up failed banks was an input that did not allow misallocations to be cleansed.

Witness CHINA. They “manage” nearly every aspect of their markets, starting with their currency. In late 2008 when their market became overheated and common people invested their life savings in stocks, a BUBBLE was blown that the Chinese then set about to intentionally prick. They raised bank reserve requirements on multiple occations, they kept interest rates high. And prick the bubble they did. The Hang Seng index plummeted from a high of 32,000 to a November low of just 10,600, a loss of 66.9% (a Seth number):

Now that the bubble has been pricked, check out their latest control input – a 25.5% increase in M2!!

April 11 (Bloomberg) -- China’s new lending surged more than sixfold from a year earlier to a record 1.89 trillion yuan ($277 billion) in March, adding to signs that growth in the world’s third-biggest economy is gathering pace.

M2, the broadest measure of money supply, grew 25.5 percent, the central bank said on its Web site today. That’s the fastest since Bloomberg began compiling data in 1998 and more than the 21.5 percent median estimate in a survey of 12 economists.

President Hu Jintao said April 1 that China’s 4 trillion yuan stimulus plan was taking effect, after urban fixed-asset investment surged 26.5 percent in the first two months. China’s lending boom contrasts with the struggle in the U.S. to rid banks of illiquid assets and efforts by central banks from Switzerland to Japan to unfreeze credit.

“China is unusual in that it has this incredible capacity to mobilize all its institutions -- central government, local governments and the entire banking system -- to boost government-influenced investments,” said Vikram Nehru, the World Bank’s Washington-based chief Asia economist.

China’s banks, which are mostly state-owned, have already met the bulk of the government’s target of at least 5 trillion yuan of new loans this year. Lending may top that level by as much as 3 trillion yuan, according to JPMorgan Chase & Co.

The explosion in credit since the central bank dropped lending restrictions in November prompted the nation’s banking regulator to warn this month that lenders face a “severe” challenge in managing their risks.

Hazard for Banks?“The central bank had to ensure it did enough to reflate the economy,” said Kevin Lai, an economist with Daiwa Institute of Research in Hong Kong. “The question now is whether it has done more than is needed.”

A concentration of loans in infrastructure projects is a potential hazard for banks, China Banking Regulatory Commission Vice Chairman Jiang Dingzhi wrote in the April 1 edition of China Finance, a magazine affiliated with the central bank. Unusual growth in discounted bills, which are used for working capital and dilute banks’ lending profits, “deserves high attention,” Jiang said.

“The biggest dangers to China’s economy and financial system come from within, not from outside,” Jiang Zhenghua, former vice chairman of China’s parliamentary standing committee, said at a financial conference in Beijing today. “The biggest of these hidden dangers is the degree of bad loans in China.”

Not everyone agrees on the risks.

Loan QualityChina Merchants Bank Co., the nation’s fifth-largest by market value, said this week that providing money for infrastructure projects will improve the quality of its book by adding more medium- to long-term loans.

Besides the risk of bad loans, the credit boom may inflate asset prices and increase the likelihood of inflation making a comeback. The benchmark Shanghai Composite Index of stocks has climbed about 34 percent this year.

“Some of the money has gone to the property market, some to the stock market,” said Lai at Daiwa Research. “It is not what the central bank wants to see.”

Excessive loan growth may “lead to inflationary pressure in the medium term, exacerbate credit risk and could potentially contribute to higher volatility in the economy,” said Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong.

“With loan growth rates exceeding official targets, bank regulators may urge more restraint, to guard against excessive liquidity,” Jing Ulrich, head of China equities at JPMorgan Chase & Co. in Hong Kong, wrote in a report today.

China’s banking regulator is examining whether it needs to curb lending after new bank loans surged to a record in March, the Shanghai Securities News reported on April 8, citing unidentified people.

Still, exports fell a record 25.7 percent in February, Chinese steel prices have dropped this year, and industries face “great difficulty,” according to Ou Xinqian, a vice minister of Industry and Information Technology.

Trade SurplusChina’s trade surplus shrank 45 percent to $62.5 billion in the first quarter, from $114.3 billion in the previous quarter. The country’s foreign-exchange reserves grew by the least in eight years to $1.9537 trillion, the central bank said today.Economic growth cooled to 6.8 percent in the fourth quarter, the slowest pace in seven years. The first-quarter figure is due April 16.

“China is unusual in that it has this incredible capacity to mobilize all its institutions -- central government, local governments and the entire banking system -- to boost government-influenced investments,” said Vikram Nehru, the World Bank’s Washington-based chief Asia economist.

Yes, Nehru is correct in that China is unique. I would say that China’s economy is more closed than the western world and thus attempts to create growth via money pumping would be more effective in creating inflation. Inflation that is causing China to do a real number on itself. Exports falling, huge new buildings and factories empty. Yes, they have surpassed the U.S. in auto sales now, but that’s not saying much for a country whose population is four times that of the U.S. What exactly are they going to produce and who are they going to sell it to? Dumping money into a semi-closed system will simply produce the next and LARGER pilot induced oscillation.

The U.S. is becoming more and more socialist and controlled. Our markets are anything but free at this point. One thing that can be forecast as a result is an increase in the magnitude of the cycles and volatility. Hopefully our economic aircraft can maintain structural integrity until it comes in for a safe landing. If that’s possible…

Martin Armstrong wrote a piece on China and controlled markets that is quite relevant. I hope you’ll find the time to read it. The New Face of China.pdf

Perhaps China and the U.S. could learn something from the aviation industry. The first would be how to do forensic accident investigation and how to implement the lessons learned from those accidents. Perhaps a simple diagram showing what inputs to apply or not to apply during oscillations would be appropriate?